But there are also sensible people who are hesitant to back fundamental reform.

Consider what Reihan Salam just wrote for National Review. He starts with a reasonably fair description of the proposal.

The original flat tax, championed by the economists Robert Hall and Alvin Rabushka, which formed the basis of Steve Forbes’s flat-tax proposal in 1996, is a single-rate tax on consumption, with a substantial exemption to make the tax progressive at the low end of the household-income distribution.

Though if I want to nit-pick, I could point out that the flat tax has effective progressivity across all incomes because the family-based exemption is available to everyone. As such, a poor household pays nothing. A middle-income household might have an effective tax rate of 12 percent. And the tax rate for Bill Gates would be asymptotically approaching 17 percent (or whatever the statutory rate is).

…the Hall-Rabushka tax would be highly regressive, in part because high-income households tend to consume less of their income than lower-income households and because investment income would not be taxed (or rather double-taxed).

This is a very schizophrenic passage since he makes a claim of regressivity even though he acknowledged that the flat tax has effective progressivity just a few sentences earlier.

And since he admits that the flat tax actually does tax income that is saved and invested (but only one time rather than over and over again, as can happen in the current system), it’s puzzling why he says the system is “highly regressive.”

If he simply said the flat tax was far less progressive (i.e., less discriminatory) than the current system, that would have been fine.

Here’s the next passage that rubbed me the wrong way.

…there is some dispute over whether ending the double taxation of savings would yield significant growth dividends. Chris William Sanchirico of Penn Law School takes a skeptical view in a review of the academic research on the subject, in part because cutting capital-income taxation as part of a revenue-neutral reform would require offsetting increases in labor-income taxation, which would dampen long-term economic growth in their own right.

I’m not even sure where to start. First, Reihan seems to dismiss the role of dynamic scoring in enabling low tax rates on labor. Second, he cites just one professor about growth effects and overlooks the overwhelming evidence from other perspectives. And third, he says the flat tax would be revenue neutral, when virtually every plan that’s been proposed combines tax reform with a tax cut.

On a somewhat more positive note, Reihan then suggests that lawmakers instead embrace “universal savings accounts” as an alternative to sweeping tax reform.

Instead of campaigning for a flat tax, GOP candidates ought to consider backing Universal Savings Accounts (USAs)… The main difference between USAs and Roth IRAs is that “withdrawals could be made at any time for any reason,” a change that would make the accounts far more attractive to far more people. …Unlike a wholesale shift to consumption taxation, USAs with a contribution limit are a modest step in the same general direction, which future reformers can build on.

I have no objection to incremental reform to reduce double taxation, and I’ve previously written about the attractiveness of USAs, so it sounds like we’re on the same page. And if you get rid of all double taxation and keep rates about where they are now, you get the Rubio-Lee tax plan, which I’ve also argued is a positive reform.

But then he closes with an endorsement of more redistribution through the tax code.

Republicans should put Earned Income Tax Credit expansion and other measures to improve work incentives for low-income households at the heart of their tax-reform agenda.

I want to improve work incentives, but it’s important to realize that the EIC is “refundable,” which is simply an inside-the-beltway term for spending that is laundered through the tax code. In other words, the government isn’t refunding taxes to people. It’s giving money to people who don’t owe taxes.

As an economist, I definitely think it’s better to pay people to work instead of subsidizing them for not working. But we also need to understand that this additional spending has two negative tax implications.

When politicians spend more money, that either increases pressure for tax increases or it makes tax cuts more difficult to achieve.

The EIC is supposed to boost labor force participation, but the evidence is mixed on this point, and any possible benefit with regards to the number of people working may be offset by reductions in actual hours worked because the phase out of the EIC’s wage subsidy is akin to a steep increase in marginal tax rates on additional labor supply.

The rest of Reihan’s column is more focused on political obstacles to the flat tax. Since I’ve expressed pessimism on getting a flat tax in my lifetime, I can’t really argue too strenuously with those points.

In closing, I used “friendly fight” in the title of this post for a reason. I don’t get the sense that Mr. Salam is opposed to good policy. Indeed, I would be very surprised if he preferred the current convoluted system over the flat tax.

But if there was a spectrum with “prudence” and “caution” on one side and “bold” and “aggressive” on the other side, I suspect we wouldn’t be on the same side. And since it’s good for there to be both types of people in any movement, that’s a good thing.

P.S. I got a special treat this morning. I was at Reagan Airport for a flight to Detroit at the same time as a bunch of America’s World War II vets arrived on an Honor Flight to visit the WWII Memorial.

Here’s my rather pathetic attempt to get a photo of one of the vets being greeted.

Since I’ll never be in demand as a photographer, you should watch this video to learn more about this great private initiative to honor World War II veterans.

I agree with most of what you have to say, however, additional steps can be taken to increase the efficiency of the collection process.

First, assuming for the moment that the flat tax is revenue neutral (on a static basis), FICA should be included (more on that later).

Second, rather than a standard deduction, you could have a refundable tax credit.

Why? A standard deduction, means that you don’t have a flat tax, you have two rates, zero and the flat tax, so everyone must file tax forms, even though simpler. A tax credit (which could be the same as the std deduction, $20,000 std deduction = $4,000 tax credit at 20% rate), can be distributed separately, monthly. Employers could file accurate taxes (Flat tax x gross pay), eliminating tax filing for citizens without business income.

The tax credit could be mailed electronically every month at the same amount for every adult citizen and same amount for every child. Those amounts would be deducted from current safety-net distributions.

The efficiency of this system is far simpler than the process of individual tax filing, and the savings would pay for any increased cost std deduction vs tax credit.

Taking it a step further, you could provide poverty level support, and get rid of all federal welfare, eliminating 700,000 bureaucrats.

By eliminating FICA, you can more easily start marching back retirement dates. Those who have fully paid are fully invested, those not fully paid are partially invested, so their retirement date should reflect how much they paid in.

A “Painless Tax” would get rid of investment taxes. Zeroing those taxes will cause stock value to skyrocket. The day before implementation, have a 20% tax on all accumulated gains plus non-Roth pension funds. Tax revenues would be $1T+, but the stocks would have gone up $6T. Like paying taxes on a winning lottery ticket.

The critique of Salam’s article needs to blast his claim that a flat income tax is regressive. This is a pure contradiction in terms, and its logic is that of equivocation. The equivocation is to speak of progressivity, flatness, and regressivity with two different meanings.

Saying a flat tax is regressive because low-income households’ spend a larger percentage of their income on consumption is a non sequitur. It is rooted in transferring another equivocal use of “regressive”–that of claiming that a sales tax is regressive because it is the same rate applied to consumption, while consumption is (presumably) a larger percentage of lower-income earners’ income than of a higher-income earner’s income. A 5% sales tax applied to a $40,000 earner’s $30,000 in consumption is $1500 or 3.75% of total income, but applied to a $400,000 earner’s $250,000 in consumption is $7500 or 1.875% of total income.

But the sales tax is not an income tax, and does not affect or apply to income. It isn’t a regressive tax–it’s a flat sales tax. The base is consumption, not income. A sales tax is not an income tax, and an income tax is not a sales tax. A flat sales tax rate is not a regressive income tax rate.

The putative “regressiveness” of a flat tax could consist in either of two things: 1. In a lower-income person having a smaller amount left after income tax than a higher income person after income tax. This is true. It is, however, tautological; it will always be the case, because the higher-income earner has more money. 2. In the income tax equating to a larger percentage of either consumption or non-consumption income. Again, this is tautological, since these amounts are smaller than total income.

According to this use of “regressive,” the only way for a tax to be flat (non-regressive and non-progressive) would be for it be graduated to leave either the same percentage or the same amount of unconsumed income with the earner as total income increases. Either of these requires what is actually a progressive income tax.

By the equivocated use of “regressive,” Salam falls into egalitarianism. By this misuse of the term, the only non-regressive tax structure is one that eliminates all after-tax income difference down to the lowest income. Even a progressive tax is regressive by Salam’s use of the term, until it eliminates income difference.

Regressive doesn’t mean two things with respect to taxation–it means one thing: Decreasing rate as the base increases. A flat income tax is not regressive.

Some well intentioned conservative economists have brain freeze when it comes to a few hot button issues.
The first issue relates to the “size” of the federal government. The constitution has some minor limitations about restricting the functions or interference by the federal government but there is no limit as to the size of the federal government. Good national politics, rather than resort to the courts, is the only long range hope of keeping the federal government in check. That requires thinking about the welfare of people and not just the assets of a few – a revolutionary design when you think about it. [Of course the framers expected only the male landowners to strike the political balance but that is a different issue].
The concern for “no double taxation” is misplaced because it assumes high taxation of income, on multiple occasions and/or to different entities (C corporation-stockholder-estate). Workers and their employers pay tax on labor under the payroll tax and the same payroll income, with no deductions, is taxed at the federal (and often the state) level. The after-income-tax income is taxed again when it is spent because all business taxes are passed to the consumer (and sales taxes often applied). In truth it does not matter how often income or events are taxed. The only thing that matters is how much an individual is taxed in total – and that is why low rates and broad tax bases are so important. In fact, if we taxed income, sales (VAT) and net wealth generating the rates would be closer to 2% on wealth, 4% VAT and 8% income. Another advantage of low rates is that there is little pressure for distorting tax expenditures that exist due to high rates.
Lastly use of the term “redistribution” of income (short term) and wealth (long term) is exactly what the tax code does. Our tax code (and tax like regulations) have increased the top 10% share of wealth to 75%. The next 40% (the middle class) went from 27% to 24% in 20 years. The poorer half of the population lost 70% of their wealth and now has just a 1% share. Some think the slow redistribution trends can and should continue.

I love your blog, except for one issue: Corporate Taxation. Corporations (specifically C corporations) trade reduced risk for treatment as a taxable entity. One commentator on that kinda silly chart you have said it well:

on September 26, 2011 at 2:41 pmsteve
Dan: do you really need to twist things as you do?

1 – the double tax only applies to investment income from C-corps. Investors and owners of LLCs and partnerships can reinvest profits without paying any form of double taxation.

2 – while you portray the death tax as being applicable to the person who earned the money, it should more correctly be viewed as a tax on the person receiving the inheritance. The person who leaves an estate (or who gives away more than the gift tax exclusion) is out 100% of the money, regardless of the tax rate.

3 – you fail to note that only the profits from investment income are taxed, the underlying principle is not taxed twice. The investor can always pull his money out and buy the big screen TV

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Final Note:

We must eliminate personal income taxes before we institute any sort of consumptions

My husband and I have favored the concept of a flat federal sales tax for years, but believe that charities and religious institutions would fight the concept in the belief that in an economy where donations were no longer tax deductible, their revenue source would dry up.